Charlie Tian
Charlie Tian, PhD, is an investment manager and CEO of GuruFocus.com, an investment research firm, Plano, Texas.
Nobel Prize–winning economist Paul Samuelson once said, “The stock market has predicted nine out of the last five recessions.” His wry observation was intended to capture just how challenging it is to forecast short-term moves in the complex US economy (with a total value of near $30 trillion) and the US stock market (which now has a market cap of more than $50 trillion).
Still, that doesn’t mean the financial markets are just a giant casino into which you toss your money and hope for the best. Certain time-tested indicators drawn from voluminous government, corporate and financial-market data are useful in predicting the health of our economy…the latest business cycles…and how consumers and workers are faring. These “canaries,” named after the birds whose sensitivity to toxic gasses helped warn miners of danger, can help you strategize how to safeguard your nest egg and improve your returns over longer periods.
To help you, Bottom Line Personal assembled a panel of five of our top financial professionals—economists, money managers and data scientists—to find out which canaries they find most effective in figuring out where the economy and stock market are headed and what those indicators are telling them right now…
Here are the canaries our Bottom Line experts find most useful and effective…*
How it works: This is Warren Buffett’s favorite way to assess how expensive or cheap the stock market is. He compares the value of the stock market to the size of the national economy. This percentage ratio is derived by dividing the total market capitalization of all US stocks by the latest quarterly gross domestic product (GDP) figure, and multiplying that by 100. Buffett called this “the best single measure of where valuations stand at any given moment.”
How to use it: Stocks historically have been significantly undervalued when the Buffett indicator is below 82%…fairly valued when the reading is 105% to 128%…and significantly overvalued when the indicator is over 152%. Buffett warned that it would be “playing with fire” to purchase stocks when this indicator is around the 200% mark.
What the Buffett Indicator is saying now: The stock market is quite overvalued at around 180%. Find the latest readings of the Buffett Indicator at GuruFocus.com/stock-market-valuations.php.
Charlie Tian, PhD, is an investment manager and CEO of GuruFocus.com, an investment research firm, Plano, Texas.
How it works: The White House’s agenda has a strong effect on the economy and stocks. That’s because stock market performance tends to follow the four-year presidential cycle.
How to use it: Year One of the cycle tends to be an average-performing year for the stock market with an average return of 8% over the past 75 years for the S&P 500. New administrations tend to enact painful initiatives such as tax increases, spending cuts and aggressive foreign-policy initiatives soon after inauguration when they have the most political capital and long before they face reelection. When a sitting president wins reelection, the market is stronger in Year One of his/her second term with the S&P 500 averaging a gain of 9.7%. Returns in Year Two tend to be the weakest, with a 4.6% average return. In the second half of the cycle, stocks tend to surge as the President tries to shore up the economy and push stimulus measures to keep the country out of a recession, encouraging the electorate to vote for him or his party again. Returns in Year Three averaged 17.2%, the best in the four-year cycle. The same principle carried over to Year Four, the election year, with an average 7.3% gain.
What the Presidential Election Cycle indicator is saying now: Stocks are sticking closely to the Presidential cycle with a banner Year Three and continued strong performance in 2024. Interestingly, when an incumbent like President Biden is running for reelection in Year Four instead of an open field of candidates, stock returns have an additional edge. Since 1900, the Dow Jones Industrial Average (DJIA) has been up 8.8% with a sitting president in an election year versus 5.1% with an open field.
But be careful in 2025. In the past 25 post-election years, there have been 13 bear markets and three major wars started. Republican administrations have fared much worse in post-election years. The DJIA has had a paltry average gain of 1.5% since 1950. In Democratic first years, the DJIA has returned 14%.
Jeffrey Hirsch is CEO of Hirsch Holdings, White Plains, New York, and editor-in-chief of Stock Trader’s Almanac. StockTraders Almanac.com
How it works: This continues to be one of the most reliable seasonal indicators for stock market performance. Since 1990, the S&P 500 has returned 7% in the six-month period from November 1 through April 30 but only 2% from May 1 through October 31. Possible reasons: Stockbrokers and many investors take vacations in the summer months, reducing market activity. A number of infamous stock market declines have occurred during the May-through-October period, including Black Monday in 1987 and the post-Lehman Brothers crash of 2008. There typically are increased investment flows in December due to year-end bonuses and retirement-account contributions.
How to use it: Time your annual contributions to invest before the stronger six-month period of November 1 through April 30.
What the Halloween Indicator is saying now: At press time, every month from November 2023 through March 2024 has seen positive stock market gains, with the S&P 500 up a robust 23%. Market performance is likely to slow in the weaker six-month period (May 1 to October 31) as investors digest their gains and reduce risk due to Presidential election uncertainty.
—Jeffrey Hirsch
How it works: This popular technical indicator for analyzing the direction of the S&P 500 is expressed as a line on a chart representing the index’s average closing price over the last 200 trading days (40 weeks). That length of time generally is considered long enough to capture trends yet short enough to represent useful data for traders.
How to use it: It is a bullish sign if the closing price of the index on a given day is above its 200-day SMA. A price below the average may indicate a correction has begun. But you don’t want to make trading decisions based solely on the 200-day SMA because it does give false signals and can reverse course quickly in volatile markets. Use this indicator in conjunction with other economic data such as inflation and interest rates to understand why the stock market is trending up or down.
What the 200-Day SMA is saying now: The S&P 500 has been in a steady upward trend and sits about 9% above its 200-day SMA. Find the latest S&P 500 200-day SMA at
WSJ.com/market-data/quotes/index/SPX/advanced-chart.
Bob Carlson is editor of the Retirement Watch newsletter, managing member of Carlson Wealth Advisors and former chairman of the board of trustees of the Fairfax County (Virginia) Employees Retirement System.
RetirementWatch.com
How it works: Claudia Sahm, former Federal Reserve economist, discovered a simple real-time indicator of economic recession based on labor-market conditions. It has worked reliably since the 1970s. Look at the average national unemployment rate over the past three months. If it has risen 0.5 percentage points or more above the lowest three-month average during the previous year, then the US is in a recession.
How to use it: Unemployment has increased at a moderate pace over the past year, fueling expectations of a “soft landing” for the US economy. But recessions are sneaky, and it’s easy for investors to get caught off-guard. It can take months for the Federal government to declare an official recession, and by that time, stocks likely have already fallen. Recessions are the most common cause of bear markets.
What the Sahm Rule is saying now: We’re still in the clear…for now. The unemployment rates’ three-month moving average was recently 3.8%. That’s 0.3 percentage points higher than the lowest three-month moving average of the past 12 months. Find the latest Sahm Rule indicator data at CurrentMarket Valuation.com/models/sahm-rule.php.
Robert M. Brinker, CFS, is editor of Brinker Fixed Income Advisor, Littleton, Colorado. BrinkerAdvisor.com
How it works: Popularized by Yale University finance professor and Nobel laureate Robert Shiller, this indicator is similar to the traditional price-to-earnings ratio (P/E) of the companies in the S&P 500, except that the denominator is based on 10-year average inflation-adjusted earnings instead of trailing one-year earnings.
How to use it: By comparing the current S&P 500 CAPE to its average CAPE over the past century, you can get an estimate of future market returns over the next decade.
What the S&P 500 CAPE is saying now: Valuations are stretched for the stock market right now, and investors should expect much lower-than-normal performance going forward. The CAPE was recently at 34.41. That translates to an annualized expected forward return of about 4% for the S&P 500 index over the next decade. That 4% is based on a model created by plotting the CAPE in a month against the subsequent rolling 10-year annualized return from the S&P 500 including dividends. Find the latest CAPE data at ShillerData.com.
Elliott Gue is cofounder of the investment-publishing company Capitalist Times, McLean, Virginia, and co-editor of the Energy & Income Advisor newsletter. EnergyAndIncomeAdvisor.com
How it works: Sentiment indicators gauge market psychology through the perspective of participants rather than looking at economic or market data points. Each week, the American Association of Individual Investors (AAII), a nonprofit organization of small investors, surveys its 170,000 members about how optimistic or pessimistic they are about the stock market for the next six months.
How to use it: This is a contrarian indicator. When most investors are bullish, that leaves little cash on the sidelines to commit to stocks and drives the market higher, so the probability of a sell-off is higher. The opposite is true when most investors are leaning bearish—that’s a good time to add to your equity holdings. I look for trends above and below the sentiment averages since the survey began in 1987—bullish, 37.5%…bearish, 31%…neutral, 31.5%.
What the AAII Bull-Bear Survey is saying now. For the week ending April 24, the survey results were bullish, 32.1%…bearish, 33.9%…neutral, 33.9%. The bullish strength is now 10 points below the levels we had in late summer 2023, when we had a 10% correction. Get the latest AAII Bull-Bear Survey data at AAII.com/sentimentsurvey.
Indicators should be just one part of your toolkit when forecasting and making investment decisions… not the sole factor. Just because an indicator signals that stocks are expensive or cheap doesn’t mean that they can’t get much more expensive or much cheaper. You need to consider other economic and company data and analysis, as well as your own risk tolerance and time horizon.
The shorter the duration of the forecast, the less likely it will be accurate. Historically, the chances of the S&P 500 index rising or falling tomorrow are about 50-50. The longer your investment horizon, the more reliable indicators can be and the better your odds of success. After a one-year period, the stock market has had a positive outcome 73% of the time over the past century… after a 10-year period, 94% of the time.
Make only incremental changes. For most small investors, it is best not to try to time the market with big bets. Keep the core of your portfolio fully invested at all times. Use the information you get from canaries to make modest and incremental tweaks to your portfolio, turning a bit more defensive or aggressive ahead of the big shifts you see coming.
